Community Voices: Learn the ABCs of inherited IRAs

Lately I've been dealing with people who require advice as to how best to deal with an inherited IRA. Considerable value would be lost if you ignore the distribution rules specific to beneficiaries.

Joseph Marshall

Lately I’ve been dealing with people who require advice as to how best to deal with an inherited IRA. Considerable value would be lost if you ignore the distribution rules specific to beneficiaries.

The rules are simple if you are the spouse of the account holder and they were under 70½ years old (rules are slightly different if over 70½) upon their death.

You can simply transfer the IRA to you as an IRA; open an inherited IRA where you must begin distribution no later than Dec. 31 of the year that the account holder would have reached 70½; open an IRA and defer distributions until Dec. 31 of the fifth year after the year in which the account holder died; or take a lump sum distribution where you will pay income tax on the distribution all at once.

It’s fairly clean-cut except if you are a non-spouse beneficiary. What are your options? 1. You can transfer funds to an inherited IRA in your name using the five-year method. Which means that after five years, you must have all funds withdrawn, will not incur the 10 percent penalty, and you will pay all the tax due but you’ve had hypothetically five years of growth. 2. You can take a lump distribution and pay your income tax immediately. 3. You can open an inherited IRA using the life expectancy method. This method requires education and advice.

Distributions from inherited retirement accounts to nonspouse beneficiaries are not rollover eligible. If the intent is to allow inherited amounts to continue benefiting from the tax deferral, you must be sure that only the amounts that the beneficiary wants to (or should) distribute are withdrawn.

Unfortunately, beneficiaries often make the mistake of having inherited account balances distributed due to filing incorrect paperwork.

There is actually case law that supports the serious consequences that can result from getting improper advice.

Mrs. Smith (not her real name, but real case) inherited two IRAs from her aunt. Both IRAs were held with different banks. Mrs. Smith visited both banks and explained to the representatives that she wanted to transfer the amounts to her on a nontaxable basis.

Both banks issued checks for the accounts to Mrs. Smith. She deposited both checks into her regular bank accounts because she thought that the transfers were processed as a nontaxable transfer. She did not include the amounts on her tax return. The IRS determined a deficiency of $41,244 on her tax return. She took the IRS to court, lost, and as a result she owed the IRS $41,244 in income tax.

What went wrong? Mrs. Smith’s intent was to preserve the tax-deferred status of the IRAs. She should have established an inherited IRA with her financial institution of choice and had the new financial institution submit transfer requests for the IRAs with instructions to pay the amounts directly to her IRA.

Any movement of assets between inherited retirement accounts must be done via trustee to trustee transfers accompanied by explicit delivery instructions.

With accumulation of wealth over the last three decades, and with uncles, aunts and siblings living longer, we are finding more and more of these mistakes being made. Be informed and be prepared as best as you can.